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Computers, the PPT, and Paulson's Redemptions
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Thus far, the stock market collapse that began April 26 has occurred in a very orderly fashion. Aside from the May 6 Flash Crash, the drops have been sharp, but not too severe (usually 2% or so per session).
I believe there are two primary reasons for this seemingly orderly decline. They are:
- Computer trading programs dominate all market action
- The presence of the PPT to stop a full-blown Crash
I’ve discussed #1 countless times on these pages. Today, high frequency trading programs (HFTPs) account for some 70% of market volume. On some days, the amount of front-running they do results in one individual company (often Citigroup or Apple) accounting for as much as 10% of all market volume.
So how do the HFTPs explain today’s orderly decline?
In order for HFTPs to really work, they need REAL orders from actual investors to front-run. Otherwise the market is entirely comprised of HFTPs simply moving blocks of shares back and forth between each other without any real buying or selling power.
As I’ve noted repeatedly in the last year, REAL stock orders have been in a massive decline over the last 15 months. As the market became more and more disconnected from reality, more and more investors stopped participating.
This process was further exacerbated by the fact that many US investors are now actively pulling money from the stock market. All told investors have pulled $32 billion from mutual funds since the May 6 Flash Crash. Because mutual fund cash levels were at historic lows before the Flash Crash (meaning that the industry had gone “all in” to the long-side), this means that funds have to sell positions in order to return money to investors:
Thus, the number of real orders in the market is in a serious decline. Because of this, HFTPs have few folks to front-run, which is why the rallies don’t last. Instead, what happens is HFTPs pour into stocks at the market open only to find that there isn’t any real buying power coming in after them. Consequently, they have to sell these positions later in the day (most HFTPs end the day in 100% cash), which results in the market collapsing.
I’ve written before that HFTPs act as parasites, making the market sick. When an animal is overrun by parasites, it loses its strength and vitality. This is precisely what we’re seeing in the stock market’s rallies today: weakness, low vitality, and the urge to collapse.
So why aren’t we seeing a full-blown rout like we did in the Autumn of 2008?
The answer to this comes from #2 in the list of reasons why the market is falling in an orderly fashion: the Plunge Protection Team is active.
Thus far, every time stocks collapse we’ve seen either a “floor” put in under the market OR a stick-save in the form of late day manipulation (like today and yesterday).
You can see this very clearly in a five-minute chart of the S&P 500. Literally every time stocks come unhinged, they quickly hit a floor of some kind and the collapse stops. This is why we’re seeing daily drops of 2% instead of 4% or 6% like we did in the Autumn of 2008.
Of course, the PPT was active in the Autumn of 2008 too. However, at that time the selling power was so great that there was nothing it could do. We have yet to reach that point in this Collapse (we will at some point in the future) which s why the collapse is orderly… for now.
Having seen the Fed and PPT throw everything they’ve got at the market over the last 15 months, investors are hesitant to bet heavily on the short side. For this reason, the selling pressure has not yet reached panic levels. In plain terms, investors have begun to grow worried about a double-dip in the US economy, but they have not yet realized just how bad things are... nor just how detached the stock market is from economic realities.
Moreover, there are rumors swirling that the Fed may attempt a massive second round of Quantitative Easing: something in the ballpark of $2.5 trillion or so. No one wants to go all out to the short-side with this kind of talk occurring. Whether or not the Fed will do this is impossible to say. Political pressure regarding the bailouts and stimulus has grown dramatically and we ARE in an election year.
Should the Fed opt to go this route the effects will likely be ephemeral. Countries in both Europe and Asia (particularly Germany and China) have begun imposing austerity measures to reign in their spending. So if the US announces QE 2.0 we’re likely going at it alone.
So if the Fed DOES go this route, the subsequent rally will be short-lived. Guessing how short-lived at this point is useless. But the fact remains that QE 2.0, if it emerges, would send a clear signal that the Fed’s previous efforts to fix the financial system have FAILED. No one would believe that a more aggressive version of the strategies that failed would fix anything. And so we would likely see a brief relief rally in stocks coupled with an explosion higher in Gold.
In the mean-time, the precious metal has been taking a beating, falling from its all-time high of $1,249 to $1,193 in short order.
It’s been an abrupt and brutal collapse brought about by “behind the scenes” machinations in the Gold market.
For one thing, famed hedge fund manager John Paulson has been getting hit with redemptions. Paulson first rose to fame when he produced triple digit gains for investors in the 2008 Financial Crisis, netting himself and his clients billions.
His fund has since swelled to become the biggest hedge fund on the planet with $33 billion in assets under management. A huge Gold bug, Paulson has roughly 30% of this $33 billion invested in gold and precious metals stocks (he’s got over $3.5 billion invested in the Gold ETF (GLD) alone)
However, in the last six months things haven’t been to peachy for Paulson. His fund lost nearly 7% in June and is down some 8% for 2010. He’s consequently been getting slammed with redemptions, two billion dollars’ worth in the month of June alone.
Paulson, like most fund managers, is likely selling some of his positions in order to meet these redemptions. I cannot state as a fact that he is liquidating the Gold ones to do this, the timing between Gold’s sharp drop and when Paulson would have sold to meet redemptions is “interesting” to say the least.
From a technical standpoint, Gold is struggling at current levels, having fallen below its 50-DMA. As the below chart shows, the 50-DMA is now acting as strong resistance on the upside.
Support is at $1175. Watch that level closely, if it holds, we’re going to see a strong rebound. If it doesn’t we’re likely heading to test the 200-DMA at $1141.
Good Investing!
Graham Summers
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